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Clarifying 'Undue Hardship': Discharge Remains Possible, but Not Easy

By Rudolph J. Di Massa and Diane J. Kim
December 22, 2022
The Legal Intelligencer

Clarifying 'Undue Hardship': Discharge Remains Possible, but Not Easy

By Rudolph J. Di Massa and Diane J. Kim
December 22, 2022
The Legal Intelligencer

Read below

On Aug. 24, President Joe Biden announced the plan to forgive up to $10,000 in federal student debt for qualifying borrowers. This relief, however, was challenged in the courts and is now pending before the U.S. Supreme Court.

In the interim, Biden’s administration has sought to address student loan debt relief through another forum: the bankruptcy court. On Nov. 17, Biden’s administration published instructive guidance to the Department of Education and the Department of Justice on how to treat student loan debt relief in bankruptcy court by standardizing the burden of “undue hardship” under Section 523(a)(8) of the Bankruptcy Code.

The Undue Hardship Standard

Generally, student loans may be discharged in bankruptcy only if the student loan imposes an “undue hardship” on the petitioning debtor. The “undue hardship” burden is not only undefined by Congress; it is a standard that has generally been granted only in exceptional circumstances. In interpreting whether a debtor’s student loans pose an undue hardship on the debtor, courts either apply the Brunner test (Brunner v. New York State Higher Education Services, 831 F.2d 395 (2d Cir. 1987)), or the “totality of the circumstances” test. Under the totality of the circumstances test, a bankruptcy court considers: the debtor’s past, present, and reasonably estimated future financial resources; the debtor’s—and any dependent’s—reasonably necessary living expenses; and other relevant facts or circumstances that are unique to the case that might prevent the debtor from paying the student loans in question while still allowing the debtor to maintain a minimal standard of living, even when aided by a discharge of other prepetition debts.

‘Parvizi v. United States’

In Parvizi v. United States (In re Parvizi), 641 B.R. 729, 746 (B.A.P. 1st Cir. 2022), the Bankruptcy Court for the District of Massachusetts, and later the Bankruptcy Appellate Panel for the First Circuit, applied the “totality of the circumstances” test, which had been stipulated by the parties as the appropriate test to be applied by the bankruptcy court.

The individual debtor, Tamara Parvizi, filed for Chapter 7 bankruptcy protection in July 2018. Soon afterward, she commenced an adversary proceeding against the Department of Education to discharge more than $650,000 of student loans.

The debtor’s $650,000 student loan debt accrued while she attended two medical schools (after which she earned a medical degree) and one graduate program, pursuant to which she earned a master’s degree. Due to a set of complicated circumstances, the debtor, despite having earned two post-graduate degrees and being fluent in four languages, could not find employment in her preferred field of psychiatry. While she began a residency program in psychiatry that paid her an annual salary of $50,000, she did not complete the program because of a “conflict with the program director,” and she ultimately resigned from the program. Instead, the debtor chose to work three jobs: as an adjunct professor teaching biology; tutoring; and substitute teaching, earning somewhere between $20,976 and $41,336 annually. The evidence at trial revealed that the debtor had monthly surplus income ranging from $400 to $1,800. Unfortunately, the debtor admitted to spending all of her discretionary income without paying anything to defray her student loan debt.

The debtor admitted that she never made a voluntary payment to the Department of Education because of her belief that she had been “bamboozled out of [her] education.” Indeed, even when the debtor received a $100,000 inheritance while her student loans were in default, she eventually spent all of her inheritance money without making any provision for payment toward her student loan indebtedness.

Additionally, the evidence at trial showed that the debtor had previously enrolled in a federal income-based student loan repayment program, and that she remained in the program for a period of one year. Under this program, the debtor’s monthly payments would have been based on her income; had she made these payments, her student loans would be forgiven and canceled after 25 years. However, during her one-year participation in the program, the debtor paid nothing toward her student loan debt. She then voluntarily exited the program, and explained to the bankruptcy court that she did not feel she should “pay for the mistake of [another person]” where she was “basically left … with something … really worthless.”

Ultimately, the bankruptcy court concluded that the debtor had not carried her burden to prove that excepting her student loan from discharge would impose an “undue hardship,” noting that the debtor was “highly educated, has no dependents, suffers from no physical or mental conditions that impede her ability to work, and, at age 51, likely has many more years of being able to productively work before retirement.” Additionally, the court found that, while the “debtor may not have the willingness, … she certainly has the capability, to find a higher-paying job that would better exploit her education and experience or to supplement her income with additional part-time work.”

At the same time, the court concluded that payment on $650,000 of student loan debt without an “income-based repayment program would likely be insurmountable;” it initially exercised its equitable powers under Section 105(a) of the Bankruptcy Code to discharge any debt that would remain unpaid after the completion of the income-based repayment program in which the debtor had previously been enrolled. However, the Department of Education challenged as “unripe for determination” that portion of the bankruptcy court’s order that discharged any unpaid indebtedness that might remain after the debtor completed the income-based program. Unfortunately for the debtor, the court agreed and subsequently amended its order to exclude that language.

The debtor appealed the bankruptcy court judgment, arguing that the court had: belittled her job search efforts; erroneously found that her inability to pay her student loans was due to her own lack of motivation; and disregarded the circumstances surrounding her resignation from the residency program that was paying her $50,000 per year.

The Department of Education countered the debtor’s appeal by claiming that the debtor failed to maximize her earnings and that it was “ultimately the debtor’s choice to seek additional education and, in doing so, to assume additional student loan debt.”

The Bankruptcy Appellate Panel, finding no reason to disturb the bankruptcy court’s findings, affirmed.

New Guidance on ‘Undue Hardship’

On Nov. 17, the Biden administration issued new guidance to the Department of Education and the Department of Justice in connection with student loan discharge cases.

In an effort to ameliorate the “historically low probability of success and … the mistaken belief that student loans are ineligible for discharge,” the Biden administration’s directive outlines a new test, and directs attorneys for the Department of Education and Department of Justice to recommend partial or full discharge where: the debtor presently lacks an ability to repay the loans; the debtor’s inability to pay the loan is likely to persist in the future; and the debtor has acted in good faith in the past in attempting to repay his or her student loans (notably absent from this guidance is the consideration of whether a debtor is optimizing earning potential). Unfortunately for the debtor in Parvizi, the new test would be unavailing in any event, most significantly because the debtor never made any effort to repay her student loans.

Generally speaking, the new guidance outlines a procedure by which attorneys for the Department of Justice can obtain a debtor’s student loan payment history from the Department of Education and receive other relevant information directly from the debtor. For now, it remains unclear whether bankruptcy courts will be inclined to adopt the administration’s new guidance; on the other hand, we should see some developing case law on this topic as student loan discharge cases involving the Department of Education begin to work their way through the system.

Rudolph J. Di Massa, Jr., a partner at Duane Morris, is a member of the business reorganization and financial restructuring practice group. He concentrates his practice in the areas of commercial litigation and creditors’ rights.

Diane J. Kim, an associate with the firm, practices in the area of business reorganization and financial restructuring. Prior to joining the firm. Kim served as judicial law clerk for the U.S. Bankruptcy Court for the District of Delaware.

Reprinted with permission from The Legal Intelligencer, © ALM Media Properties LLC. All rights reserved.